Net Neutrality: Will Netflix destroy the Internet?

The FCC is slated to make some decisions on the issue on net neutrality on December 21. Given a looming video-inspired bandwidth crunch, it's important those rules are less about "rights" than economics.

A recent article in Bloomberg Businessweek got me thinking about the subject of "net neutrality." The issue boils down to whether providers of Internet access (fixed-line phone networks, cable networks, mobile phone networks) should have the right to prioritize - or even block - traffic for certain services on their network. The fear is that carriers will have a strong incentive to hinder competitors to services they provide themselves, thus leveraging their control over the pipes into consumers homes to drive usages levels of those services. Phone companies might try to block VOIP traffic, or else hinder video traffic from Netflix, in order to protect revenues for their own Pay TV offering.

Of course, there are less overt ways to favor one's own offerings over that of a competitor. Comcast recently increased what L3 pays to send additional data over its network. L3, as it turns out, is now Netflix' chosen content delivery network. Comcast has also expressed a desire to institute bandwidth caps at some point, though has backed off near-term plans due to the negative publicity the declarations generated.

The problem for Comcast is one of vested interest. They have strong incentives to raise prices and institute caps that limit competition to their own fixed-line video services. This is what raises the hackles of net neutrality advocates, as it enables carriers to favor their own services without anything so obvious as slowing down packets from Netflix.

Preventing gatekeepers from using their power to lock-out competitors is certainly a noble goal. Even Ronald Reagan, a man touted by many on the right as a paragon of free market virtue, opted to turn oil pipeline companies - which are, in essence, the gatekeeper to oil consumers all across the United States - into "common carriers." This created an open market for oil over privately owned, but highly regulated, transmission pipes.

On the other hand, carriers have to generate a return on investment in order to continue to upgrade their networks. This may become a problem quite soon, if a Juniper Networks report is a fair approximation of reality.

The report predicts that carriers such as AT&T and Comcast will see Internet revenues grow by 5 percent a year through 2020. Meanwhile, traffic will surge by 27 percent annually, and carriers will need to increase their investments by 20 percent a year to keep up with demand. By this math, the carrier's business models break down in 2014, when the total investment needed exceeds revenue growth.

By 2014, video will account for more than 90% of Internet traffic. As Michael Hatfield, founder of Cyan Optics, noted in the article, "this is the most dramatic change in the network that has ever occurred."

By way of context, Juniper Networks is a vendor of networking equipment, and thus would stand to gain a lot from carriers convinced they had to buy large stacks of equipment to keep up with galloping bandwidth demand. On the other hand, the fact that Juniper Networks has an interest in painting the issue in the darkest colors doesn't mean they aren't identifying a real problem. An explosion in bandwidth demand is still very real, whether or not the economic tipping point happens in 2014, 2017 or 2020.

This has obvious ramifications to Netflix, a company whose future growth is linked to its fast-growing video streaming service. It also has ramifications for companies like Google (with Google TV) or Microsoft, who is currently in negotiations to roll out an Internet TV service for its XBOX Live and Media Center products. It also would affect me, personally, as I am one of those "cord cutters" who gave up subscription cable services in favor of video streamed over the Internet to my television (in my case, by way of my XBOX 360).

I still on occasion watch some of the over-the-air HD channels in Los Angeles, though I use Netflix's on-demand video streaming service much more frequently. When Hulu finally comes to the XBOX, I am likely to pay the subscription fee, as it has the advantage of offering a number of shows the day after they are broadcast. On demand TV works perfectly for a guy who spends all day programming, most of the evening chasing his 17-month old daughter, and then has only an hour or two later in the evening to do other things.

In the past, I have vacillated somewhat in my stance on net neutrality. My instincts run in favor of the principles espoused by net neutrality advocates, because it is a valid economic objective to avoid media oligopolies (which is really a duopoly in many places in the US, split as it is between cable operators and, increasingly, phone networks). Just as it's good that oil pipelines are prevented from playing the role of highly-profitable gatekeeper to the transmission of oil, it would be spectacular if I could pick and choose my source of media "a la carte" from thousands of providers around the world. Net neutrality would help to ensure that future materialized.

On the other hand, my economics side is very aware of the incentives principle, and network providers need profits to incentivize them to grow the network to support a video streaming future. Net neutrality advocate Google seems to concede that point, at least in part. The overload point has already been reached for mobile networks, which is the reason they proposed to exempt mobile networks from net neutrality mandates. Knowing where their "bread is buttered," however, they insisted in full-on net neutrality for fixed-line providers, an argument that furthers their goal of developing into an Internet video service based around YouTube, and is easier to make now while carrier economics are still sound.

Net neutrality advocates often speak of the right of consumers to access any Internet service they want without interference by carriers. Those on the other side speak of property rights, and the incentives needed to build the network to support more data.

I hate the language of rights, favoring a more goal-oriented approach. The goal should be to maximize choice AND maintain incentives, something that is only possible if the people making the decisions aren't trapped by the black-and-white language of "rights."

It is good to have lots of choice in terms of media services. It is also good to maintain the profits necessary to incentivize carriers to build out their network.

We are heading towards a world of bandwidth caps on even fixed-line networks, barring the development of some amazing new technology that will make streamed video take up less bandwidth, or widen the pipe faster and at less cost. If we want to ensure that competitors to carrier-offered video services are on an even playing field, then the only option is through OVERSIGHT and REGULATION.

Regulation...a dirty word to many, but so very fundamental to the proper functioning of capitalism. That, to my mind, is the biggest problem I have with some libertarians (to say "all" is unfair, as on a continuum, I can be said to share many of their views). They are like people who fixate on the engine in a car, ignoring completely that an engine on blocks doesn't do a whole heck of a lot.

Government provides the structure within which economic activity takes place. Part of that structure is rules that will attempt to maximize service choice given the constraints of a market that doesn't lend itself to hundreds of competitors naturally.

The FCC is set to vote on net neutrality rules on Dec. 21. Given the looming bandwidth crunch, it is likely to be one of their more important decisions in quite awhile.